Deborah teaches college Accounting and has a master's degree in Educational Technology.
When a business purchases goods and services, it records the purchase from and cash payments to its suppliers. In a departmental system, purchases and cash payments are tracked separately.
Recording Departmental Purchases
Ms. Shue owns Shoes 4 Her, a retail store that sells women's running shoes and boots. She's aware of the amount of purchases she makes for items that are used in the business and products that are purchased and sold to her customers overall, but she needs a method to track these items. Let's examine this process.
Shoes 4 Her needs supplies like office supplies and a phone service. The business also needs the actual shoes that it will sell to its customers. These are two different types of items.
Expenses - represent costs that a business incurs in order to generate sales such as office supplies
Inventory - represents items that are purchased with the intention of selling them to customers at a higher price than cost (called a mark-up), such as the actual shoes for Shoes 4 Her
A company can pay for its purchases using cash or on account. The phrase on account means that the company has a period of time to pay the amount they owe to the creditor. Businesses usually have 30 to 60 days to pay an outstanding amount before interest is charged on the overdue balance. These amounts are called accounts payable.
The invoice is a source document issued by the creditor and contains the necessary information to record these purchases. Businesses record their purchases on account in the purchases journal, which keeps track of:
The date the item was purchased
The company from whom the items were purchased
The invoice number
The amount owed to the supplier (also known as accounts payable)
The department that made the purchase
The last step allows management to determine how much each department is purchasing and from which suppliers.
Let's look at how Ms. Shue would record certain purchases on account in the purchases journal.
Items & Company
Accounts Payable Credit
Running Shoes Dep.
purchased office supplies from Supplies R Us
purchased running shoes to resell from The Sneaker Shoppe
purchased boots to resell from The Stylish Boot Co.
Note that Ms. Shue can easily identify the total purchases for the running shoe department ($2,000) and the boot department ($3,000) in the purchases journal.
Information from the purchases journal must be transferred to the company's general ledger which is an accumulation of all accounts and amounts relating to the company. This transfer is done using a journal entry.
Recording Cash Payments
Businesses usually pay outstanding amounts using cash or check. A purchase may be paid for right away using cash, or if the purchase was made on account, payment will usually be made by check 30 to 60 days after the item was purchased. Payments made to suppliers are recorded in the cash payments journal which keeps track of:
The date the payment was made
The account(s) involved
The name of the supplier
The check number
The nature of any discount taken by department
The amount of the purchase
Let's say that in the month of May, Shoes 4 Her made the following payments:
May 1 - Rent = $15,000 (check #45)
May 15 - paid amount owing to Sneaks Co. for a purchase made in April = $1,750 (check #46)
May 31 - paid amount owing to Les Boots Store for a purchase made in April = $800 (check #47)
Ms. Shue would enter this information into the cash payments journal.
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Suppliers often offer businesses the opportunity to take a discount on their outstanding amount in order to encourage the business to pay their outstanding invoices more quickly. Suppliers are comfortable offering small discounts of 1 - 2% for early payment as they get the cash faster and that allows them to do other things with it.
Let's use the same May payment information for Shoes 4 Her but assume that the following discounts were taken:
May 15 - paid amount to Sneaks Co. - outstanding amount - $1,750, discount for early payment - $35, total paid - $1,715
May 31 - paid amount to Les Boots - outstanding amount - $800, discount for early payment - $16, total paid - $784
Let's examine what the cash payments journal would like with the discounts.
Using this information, Ms. Shue can determine which departments are taking advantage of purchase discounts and how often this occurs. If she is looking for opportunities to cut costs, she may want to ensure that each department is taking advantage of purchase discounts offered by her suppliers.
Note that discounts are only recorded when the payment is made, as the business does not know at the time of purchase that they will take advantage of the discount for early payment. This information is only known with certainty when the payment is made. All journal entry information must be transferred from the cash payments journal to the general ledger.
A company can pay for its purchases using cash at the time of purchase or on account, meaning payment is made at a future date. Businesses record their cash purchases in a cash payments journal, and purchases on account in the purchases journal are recorded in the cash payments journal. The invoice is a source document issued by the creditor and contains the necessary information to record these purchases.
All journal information must be transferred to the company's general ledger, which is an accumulation of all accounts and amounts relating to the company. If a discount is taken by a company at the time of payment, it must be recorded in the cash payments journal as the company actually paid less cash than the total amount owing would suggest. Recording purchases and cash payments by department assists management in tracking purchases and determining which departments are taking advantage of purchase discounts.
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